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What Causes Macroeconomic Instability and is the Economy "Self-Correcting"?

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Le pouvoir de la macroéconomie : les principes économiques dans le monde réel

Université de Californie à Irvine

4.6 (1,450 notes) | 160K étudiants inscrits

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In this course, you will learn all of the major principles of macroeconomics normally taught in a quarter or semester course to college undergraduates or MBA students. Perhaps more importantly, you will also learn how to apply these principles to a wide variety of situations in both your personal and professional lives. In this way, the Power of Macroeconomics will help you prosper in an increasingly competitive and globalized environment. This course is also available in Portuguese. To join the fully translated Portuguese version, visit this page: https://www.coursera.org/learn/macroeconomia-pt/

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4.6 (1,450 notes)

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PS

Aug 06, 2018

This was an instructive course with lots of examples of the US economy and with a great explanation and tests, nevertheless sometimes I lacked some examples from the other parts of the world.

NT

Sep 07, 2015

The course is so well-organized that helps me to accomplish a systematic understanding about the field. Beyond that, thanks to the Professor, I now feel more keen on learning about this.

À partir de la leçon

The Warring Schools of Macroeconomics

What Causes Macroeconomic Instability and is the Economy "Self-Correcting"? 7:15

Rules Versus Discretion 4:38

A Balanced Budget Rule, Crowding Out, and Where the Warring Schools Converge 7:50

Enseigné par

Dr. Peter Navarro
Professor

[MUSIC]

There are three important questions we have to

ask to fully evaluate the warring schools of macroeconomics.

Number one, what causes instability in the economy

so that it deviates from its full employment output?

Two, is the economy self correcting, and if so, what

is the speed of the adjustment back to full employment output?

And three,

should the government adhere to a set of hard and fast

rules, or rather use discretion in setting fiscal and monetary policy?

So let's start with the first question.

What can drive an economy away from its full employment output?

The main stream view is Keynesian based.

It holds that instability in the economy arises from two sources.

The first,

most common problem is significant changes in investment spending.

And to a lesser extent consumption

spending, both of which change aggregate demand.

The second more occasional problem is adverse supply side shocks

which change aggregate supply. Now in contrast to the

Keynesian view, the Monetarists hold that it is inappropriate government policies

that are the major cause of macroeconomic instability.

In fact, modern monetarism is a classically based perspective.

This is because, like classical economics, monetarism argues

that the price and wage flexibility provided by competitive

markets cause fluctuations in aggregate demand to alter

product and resource prices, rather than output and employment.

The problem, as Monetarists see it, is that wages

can't adjust freely downward because of government policies, ranging

from minimum wage and pro-union legislation, to guaranteeing prices

for farm products, pro-business monopoly protections, and so on.

Even more importantly, the Monetarists also blame the

government's clumsy and often misguided attempts to achieve greater

stability to activists monetary policies.

This problem of a misguided government is rooted

in the Monetarists view of the economy through the

lens of the Equation of Exchange and quantity

theory of money, which we examined in lecture four.

You may recall from that lecture that if the velocity of money v is

stable, and real output q is independent of the price level, changes in the money

supply m can only lead to changes in inflation.

Of course it is a matter of some debate

as to whether the velocity of money is stable.

And in fact Keynesians take the view that velocity is actually unstable.

From the perspective of supply side economics, supply siders agree with

the Keynesians that macroeconomic instability

can result from supply side shocks.

However, in this regard supply siders at least partly

share the classical and monetarist view that it is

often the government, not just droughts and oil price

hikes, that is to blame for causing the shocks.

Of particular concern to the supply siders are

high tax rates and regulations that reduce supply incentives.

Let's turn now to our second area of controversy,

the question of whether the economy self corrects.

In this debate, it not just a question of

whether an economy corrects itself when instability does occur,

economists also disagree as to the length of time

it will take for any such self correction to happen.

In this regard, both the monetarists and the new

classical economists take the view that when the economy occasionally

diverges from its full employment output, internal mechanisms within

the economy automatically move it back to that output.

This perspective is associated with the theories of

adaptive and rational expectations that we have already discussed.

This figure relates the new classical view of self correction.

Here, an unanticipated increase in aggregate demand

from AD1 to AD2 moves the economy from point A to point B.

This causes the price level to rise from P1

to P2, as real output increases from Q1 to Q2.

Now, in a new classical world, what do you

think happens next to bring the economy back to Q1?

And what do you think will happen to the price level.

In the long run, nominal wages will rise to

restore the real wages that have been eroded by inflation.

This causes per unit production cost to rise, and eventually the short run

aggregate supply curve shifts leftward and inward, from AS1 to AS2.

As the economy moves from point b to point c, the price level rises from P2 to P3,

and the economy returns to the full employment level of Q1.

Now what about the speed of adjustment issue?

Well here there is much controversy,

even within the various schools of macroeconomics.

For example, classically orientated monetarists usually hold

the adaptive expectations view that people form

their expectations on present realities, and only

gradually change their expectations as experience unfolds.

This implies

that the shifts in the short run aggregate supply curves that we have

just illustrated, may not occur for two or three years or even longer.

On the other hand, the new classical economists accept the rational

expectations assumption that workers anticipate some

future outcomes before they even occur.

This suggests that when price level

changes are fully anticipated, the adjustments

in our figures occur very quickly, indeed even instantaneously.

So what do the Keynesians think about all this?

Well, almost all economists today

acknowledge that new classical economics has

taught us some important lessons about the theory of aggregate supply.

None the less, most mainstream economists strongly disagree

with new classical rational expectations theory on the question

of downward price and wage flexibility.

In this regard, while the stock market,

foreign exchange market and certain commodity markets

experience day to day or even minute

to minute price changes, including price declines.

This is not true in many product markets, and in most labor markets.

Indeed, there appears to be ample

evidence, say mainstream economists, that many

prices and wages are inflexible downward for long periods.

As a result, it may take years for an economy to move from recession

back to full employment output, unless it gets help from fiscal and monetary policy.

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